Rural Delivery: Fonterra puts cost cuts before building revenue at its peril

By GUENTHER MUELLER-HEUMANN*

Fonterra's long-term success, measured in the level of payouts to its shareholders, will come from a different side of the business than the many short-term cost cutting and organisational problems preoccupying everyone.

For a start, applying the normal business profit model does not make sense because, like many other co-ops, this is a supplier-owned company. In such an operation "profit" is really two things; the price the co-op pays to its shareholders for supplying it with goods plus the "left-over profit payout" after having paid for supply.

A "technical" loss, as in Fonterra's case this year, can simply occur by paying out too much for the "supply and profit".

Ultimately, the owner-suppliers of Fonterra will get the biggest possible payouts if the company is successful in its markets as well as keeping costs down. Listening to the current discussion, it seems the main contributor to profitability is cost efficiency. The revenue side seems to be taken as a given. That is a recipe for disaster.

The export business Fonterra inherited from the Dairy Board, and its future development to become our first multinational food company, are two different things.

The joint venture with Nestle, for example, is already a learning experience "beyond exporting", although this was not the coup it seemed to be. Nestle was probably afraid this new little dairy monster from New Zealand would go it alone and leave them (their major supplier) out in the cold of the Americas. So they did the pre-emptive thing and got Fonterra to agree to a "supply guarantee". That is basically what we are talking about. Fonterra will learn a lot in the process.

The mindset that governs exporting is very different from the mindset that governs a multinational operation.

Successful international companies export and import in their international operations, but are not exporters only. Nestle is not mainly a Swiss export company. The trick is to get away from the time-honoured thinking of "exporting" based on competitive advantage (the grass grows faster in NZ ) and understand that you are a marketer in many overseas countries which has to understand those markets to be successful.

Nestle is built on understanding marketing in the many countries in which it operates. Exporting/importing in an international operation is rather seen as a logistic link between the countries in which a company operates.

Fonterra and its predecessor has had a taste of what it meant to look "beyond exporting". When the European Union declared that spreadable Anchor butter did not fit its definition of butter, Anchor brand spreadable butter was swiftly produced inside the EU from milk sourced there. Business continued almost uninterrupted until the court case against the EU was won. A mere exporter would have been shut out of the market and probably lost the business while the court case was running.

Fonterra's challenge is to continue to build its international business beyond knowing how to ship milkpowder out of the country.

The volume of domestic dairy output growth since the early 1980s has left behind the ability of the Dairy Board, and now Fonterra, to convert commodities into market value-added products.

If we compared what Fonterra has today in value-added products with the total output of the dairy industry in the early 1980s, the picture would probably look quite good. The historical growth of milk production in the amazing "free for all" system has held back the value-added conversion potential of the dairy industry.

* Guenther Mueller-Heumann is Otago University Emeritus Professor of Marketing, and now an Auckland-based consultant and seminar leader.